What Happens to My Pension/Retirement Plan When I Expatriate?

Expatriation—giving up U.S. residence and nationality, including your U.S. passport—is an admittedly radical step, as we’ve said in previous A-Letter issues.

But it’s the only way that a U.S. citizen or long-term resident can permanently disconnect from future tax obligations. (For background on this and other reasons why you might want to expatriate, click here.)

One common concern of prospective expatriates is what happens to their retirement plan after they jettison U.S. citizenship…

Here’s a summary of the rules affecting your various accounts upon expatriation:

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Social security payments. There are no restrictions on Social Security payments sent abroad unless you live in a country upon which the U.S. government has imposed trade or financial restrictions; e.g., Cuba, North Korea, or Iran.

If you’re not a U.S. citizen, depending on where you live, there may be a withholding tax of as much as 30% on the first 85% of your monthly payment. This percentage may be reduced or eliminated if there’s a tax treaty between the United States and your residence country.

Other pension payments from U.S. sources. Most such payments are treated as distributions from an ERISA-qualified retirement plan. This includes 401(K) plans and most state and federal pension plans.

If you’re wealthy enough to be a “covered expatriate,” (click here, then scroll down for the definition) there’s a 30% withholding tax on distributions from a qualified plan that would have been taxable had you remained a U.S. citizen or resident. There’s a second 30% withholding tax imposed when funds are transferred to the country you live in after expatriation. Covered expatriates can’t use a tax treaty to reduce this second withholding tax, bringing the total tax burden to 51% (30% tax on the gross payment, then a second 30% tax on what’s left).

If you’re not a “covered expatriate,” you’re only subject to a single 30% withholding tax when the pension payments are sent to another country. Again, you may be able to use a tax treaty to reduce this tax.

Individual Retirement Accounts. If you’re a covered expatriate, your IRA terminates when you expatriate and you must pay tax on the entire untaxed portion of the plan. A small consolation: If you’re under 59 1/2, the early distribution penalty doesn’t apply. If you’re not a covered expatriate, the plan doesn’t automatically terminate, but a withholding tax of up to 30% applies to cross-border distributions. Again, this tax may be reduced under a tax treaty. Simple IRAs and SEP IRAs are treated the same as a qualified plan.

Medicare. Again, you don’t need to be a U.S. citizen to enroll in Medicare. However, Medicare services are available only in the United States. Unless you have a passport from a visa waiver country (click here for the list), that means you need a visa to visit the United States. That’s generally not difficult to obtain, but unless you live in a nearby country, it’s not a very practical strategy.

In addition, you don’t want to spend enough time in the United States to again become subject to U.S. tax on your worldwide income. As a rule of thumb, that means you should avoid spending more than an average of 120 days/year in the United States over a four-year period. (Click here for the rules–they’re on page 4 of this publication).

In summary, you do NOT forfeit Social Security, retirement plan or Medicare benefits when you expatriate. The payments are taxed differently, but there are no restrictions on such payments to expatriates. But in most cases it’s not practical to sign up for Medicare benefits if you’re not U.S.-resident.

I hope that helps with some of the more complicated aspects of expatriation.

Sincerely,

Mark Nestmann

Wealth Preservation & Privacy Editor